Kitces | Nerd's Eye View - Debt & Liabilities

HUD Eliminating Fixed-Rate HECM Standard Reverse Mortgages, But HECM Saver Option Remains

nospam@example.com (Michael Kitces) — Wed, 27 Feb 2013 06:04:00 -0600

On January 30th, the Department of Housing and Urban Development (HUD) issued Mortgagee Letter 2013-01, which announced that beginning April 1, 2013, reverse mortgage borrowers will no longer be able to obtain a fixed rate on HECM Standard reverse mortgages; instead, only the HECM Saver loans, with smaller loan limits, will be available with a fixed rate option. Those who wish to borrow a lump sum using a HECM Standard reverse mortgage in the future will be required to select an adjustable rate structure, just as they must do now under either the monthly income or line-of-credit payment options.

While the change is significant to the reverse mortgage industry, given that a large and rising percentage of reverse mortgages in recent years have been established under the fixed-rate structure, from the planning perspective the impact is likely to be more limited, as many planners have only recently begun to consider reverse mortgages for clients when the less expensive HECM Saver loan became available (and which can still be done with a fixed-rate structure). In addition, many reverse mortgage strategies - including some highlighted in recent years in the Journal of Financial Planning and The Kitces Report - are based upon the monthly income or line-of-credit payment options, which require an adjustable interest rate loan structure anyway.

Perhaps the greatest irony of the HUD change, though, is its reported reasoning: a rise in defaults by fixed-rate borrowers who extracted the maximum equity from their home, found it wasn't enough, and subsequently began to fail making their property tax and homeowner's insurance payments, triggering a reverse mortgage default. In other words, HUD is finding that it's very problematic when consumers use reverse mortgages as an income-of-last-resort solution, instead of engaging in the reverse mortgage earlier as an income source coordinated as a part of the individual's overall financial plan - guidance that would perhaps be more useful to both consumers, and financial planners too!

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An Efficient Solution To Implement Intra-Family Mortgage Loan Strategies

nospam@example.com (Michael Kitces) — Wed, 23 Jan 2013 07:02:00 -0600

In the ongoing difficult borrowing environment, some potential homebuyers have found the best way to finance a purchase is not from a major commercial bank, but from the "family bank" instead through an intra-family loan. And as long as IRS guidelines are followed, the transaction can be remarkably appealing, with more flexible lending terms, IRS-required Applicable Federal Rates that are still lower than commercial mortgage rates, the potential to still deduct mortgage interest payments for the borrower, avoidance of origination and many other mortgage transaction fees, and the simple benefit that all the interest and principal payments ultimately stay in the family. A major downside, however, is that to ensure the IRS truly respects the transaction - and to receive some of the tax benefits as well - formalities of the loan should be honored, including drafting a promissory note, recording the mortgage against the residence in the proper jurisdiction, and completing actual payments of interest and/or principal. Fortunately, a new solution has emerged - a company called National Family Mortgage, that completes all of the required documentation, records the mortgage, helps to service the loan, and even issues the requisite IRS reporting forms, all for a fraction of the cost of a traditional mortgage loan origination fee. While this won't likely mark a great boom in intra-family mortgage lending, it nonetheless makes the strategy far easier for advisors to implement efficiently for clients!
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Why Keeping A Mortgage And A Portfolio May Not Be Worth The Risk

nospam@example.com (Michael Kitces) — Wed, 02 May 2012 06:17:00 -0500

Planners have long recommended that clients save and invest, even while they have a mortgage, since the long-term return on equities generally exceeds the interest rate on a mortgage. Yet in reality, investors don't simply choose to invest in equities because the return is higher than a fixed alternative; instead, investors demand an equity risk premium over and above the risk-free rate to make equity investing worthwhile. For the traditional investor, the equity risk premium has represented the excess return of stocks over long-term government bonds. Yet for the mortgage borrower, the available "risk-free return" isn't just a government bond, but to prepay the mortgage and eliminate the interest cost! As a result, while the investor looks for an equity risk premium over government bonds paying 2%, the mortgage borrower actually shouldn't invest in stocks unless there's an expectation to earn an equity risk premium over a mortgage interest rate that might be 4% to 5%! Consequently, clients should prepay their mortgages unless they expect a full 9%-10%+ return on equities in the current environment that sufficiently rewards them for the risk!
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Looming Mortgage G-Fee Increase Puts Time Pressure On Mortgage Decisions

nospam@example.com (Michael Kitces) — Mon, 06 Feb 2012 20:36:14 -0600

In December, Congress passed the Temporary Payroll Tax Cut Continuation Act of 2011, which extended the 2 percentage point payroll tax "holiday" of 2011 into the first two months of 2012. However, to offset the nearly $20 billion cost of the payroll tax cut extension (along with a few other provisions), Congress adjusted the so-called guarantee fee charged by Fannie Mae, Freddie Mac, and the FHA, mandating that the fee must rise by at least 10 basis points. The new g-fee increase is set to apply beginning on April 1, 2012 (no fooling!), and its effects are already being felt as borrowers look to set 45- and 60-day rate lock guarantees on current purchases and refinances. The net impact to clients: if there's a purchase or refinance being considered, it could be worth many thousands of dollars to get the loan done as soon as possible.
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Why Is It Risky To Buy Stocks On Margin But Prudent To Buy Them "On Mortgage"?

nospam@example.com (Michael Kitces) — Mon, 24 Oct 2011 08:48:00 -0500

Clients who need to improve their prospects for retirement generally have three options: spend less, save more, or retire later. Technically, there is a 4th option - grow faster - but it is typically dismissed due to the risk involved in investing for a higher return. In practice, clients rarely seem to dial up the portfolio risk trying to bridge a financial shortfall in retirement, and taking out a margin loan just to leverage the portfolio to achieve retirement success would most assuredly be deemed imprudent and excessively risky. Yet at the same time, a common recommendation for accumulators trying to bridge the gap is to keep any existing mortgages in place as long as possible, directing available cash flow to the investment portfolio, and giving the client the opportunity to earn the "risk arbitrage" return between the growth on investments and the cost of mortgage interest. There's just one problem: from the perspective of the client's balance sheet, buying stocks on margin and buying stocks "on mortgage" represent the same risk and the same leverage, even though our advice differs. Are we giving advice that contradicts ourselves?

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Should You Ever Take Out A Loan To Make A 401(k) Contribution?

nospam@example.com (Michael Kitces) — Mon, 26 Sep 2011 13:44:50 -0500

Borrowing money to invest is a risky thing for individuals to do. While it's a common path for businesses - borrowing money to plow into investments, infrastructure, staff, expansion, etc. - it is done in part because business structures allow for limited liability; in other words, we often borrow in business specifically because the debts cannot track back to business owners the way individual borrowing can. Accordingly, for most individuals, the only major debt that is taken at all is a mortgage to purchase a house, and only because that's a "long term" investment (and because we couldn't afford a house any other way); most other forms of individual debt are considered "bad" debt and only used as a necessity to be paid off quickly (e.g., credit cards or auto loans). As a result of these attitudes about debt, I'm not certain I have ever seen a financial planner tell a client "since you're low on cash flow right now, you should take out a loan so you can have money to buy stocks in your 401(k) this year." Tax deferral on retirement contributions aside, it's just viewed as too risky by most to borrow money just to invest in equities in a typical investment account. There's just one problem... by telling clients to keep their mortgages as long as possible while building their retirement accounts, we're doing the exact the same thing: telling clients to invest in the stock market by borrowing.
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